Money Funds Still Suffer for Their Sins

— October 1, 2013

By Philipp Schnabl and Marcin Kacperczyk

Funds whose sponsors had less money fund business experienced smaller cash outflows, were more likely to provide financial support during the market-wide run of September 2008, and were more likely to exit the industry or change their names.

Money market fund managers would likely be among the first to testify that the recent financial crisis lingers on, as billions of dollars that flowed out from those funds after Lehman imploded and the buck was broken have yet fully to trickle back. Philipp Schnabl, assistant finance professor at NYU Stern and Marcin Kacperczyk, professor at Imperial College, London, recently completed a thorough study of why investors fled, what characteristics may have precipitated funds’ vulnerability to runs and which types of funds were most likely to recover.

In “How Safe are Money Market Funds?,” the authors categorize the funds and their outcomes according to risk taking and sponsorship. Funds assuming the most risk were sponsored by companies with relatively more money fund business and higher financial strength. Funds whose sponsors had less money fund business experienced smaller cash outflows, were more likely to provide financial support during the market-wide run of September 2008, and were more likely to exit the industry or change their names.

Kacperczyk and Schnabl conduct a thorough assessment of the way funds, traditionally (but no longer) considered almost as stable as cash, were managed in regard to risk taking in the 2007 to 2010 timeframe. Starting in August 2007, Schnabl points out, money market funds, “experienced an unprecedented expansion in their risk-taking opportunities.” And when managers saw these opportunities, some went ahead and took them.

At that time, spreads relative to US Treasuries had increased dramatically because mortgage defaults were on the rise, and, consequently, returns to investors were multiplying. This scenario suggests that the funds’ underlying asset risk had changed fundamentally, Kacperczyk says, and when Lehman fell, investors ran, taking with them more than $300 billion. The run was halted only when the government announced it would insure all fund depositors.